Monday, January 13, 2014

Particle Physics is a Poor Analogy to Human Markets

“ECONOMIC PROCESSES
AND THE PROSPERITY OF COUNTRIES HAVE BEEN LIKENED TO THERMODYNAMIC SYSTEMS,
SAYS S. ANANTHANARAYAN who posts (11
January) on The Statesman (India) HERE

“Adam Smith, the
18th century father of modern economics, said that there was an “invisible
hand” that guided players in a market, always seeking their own gain, to act,
nevertheless, in a way that led to a better distribution of goods and better
prices for the consumer than any effort specifically in that direction could
have.

The laws of physics
have it that any particle, stationary or in motion, interacts with other
particles so that the energy of motion that it brings stays constant — either
retained or passed on to the other particle. The other particle also follows
this principle and the first particle may end up with more energy than it
started with, but thanks to something given up by another particle. The result
is that the speeds of millions of particles in motion — for example, the
molecules of a gas distribute themselves so that there are very few particles
with high energy or with low energy, but with a great many at a point in
between. And this point can be shown to be the one where there is the greatest
number of different ways for the particles, with various speeds of motion, to
have the same total energy. It could also be called the point of most equitable
distribution of energy, given the dynamics of collisions and the conservation
of total energy.

The comparison of
economic activity with the properties of the molecules of a gas comes about by
treating the money with an individual as equivalent to the speed of a molecule.
In transactions between individuals, like in collisions of molecules, there
would be an exchange and redistribution of money. The comparison is valid
because the total money in a system, like the total energy in a gas, is
conserved or stays constant. The proposition then was that, after allowing for
the possibility of debt, which does not exist in molecules of a gas, money also
distributes itself, with mathematical precision, in the same way as the speed
of molecules. In studies of actual distribution of money, to verify the notion,
there is a difficulty of different currencies and purchasing power, in
cross-border comparison. Studies have, hence, been made of the distribution of
income in the USA, UK, Australia, European Union countries, Romania and others,
and the results have been that the distribution of the number of persons in
increasing income ranges, in most cases, over a group of 97 per cent of the
population, is exactly like in the case of a gas.”

Comment

Adam Smith did not
say “that there was an “invisible hand” that guided players in a market, "always
seeking their own gain, to act, nevertheless, in a way that led to a better
distribution of goods and better prices for the consumer than any effort
specifically made in that direction could have”.

That is a later
conclusion of some modern economists who did not read clearly the relevant pages and
the specific paragraphs in Wealth Of Nations and instead to have rushed to
conclusions that were not justified by the written evidence.

Smith’s actual
conclusion from his example where he used the metaphor of “an invisible hand”
was in fact fairly modest metaphorical description of a motivation and did not justify the construction placed on
it.

First, Smith used the
metaphor to “describe in a more striking and interesting manner” the motive of
a merchant, who faced with considerable concerns about the extra risks involved
in sending his capital out of his own country to a foreign one, in which he was
unsure about the probity of those he dealt with abroad and the consequent extra
risks of using a foreign legal system to obtain redress, should he be deceived,
took the more secure route of investing his capital to trade with merchants
in his own country.

Secondly, the
merchants, who for these reasons preferred investing in “domestic industry”,
arithmetically added to the domestic capital that itself added to the domestic
total of “annual revenue and employment”.That is all.There is nothing about it “led to a better distribution of goods and better prices for the consumer
than any effort specifically in that direction could have.”

Thirdly, this
misreading (I believe non-reading is a better description of proponents of
“Petracrch’s” assertion) was extended by modern economists to cover the best of all
worlds, including ideas of “harmony” and ideas that even “selfish” motivations
(after Paul Samuelson, 1948; which he later explicitly qualified) would lead to
this economic nirvana.

Adam Smith’s
arithmetical point was fairly modest because obvious – if you add to total domestic investment then
you get more total product from enhanced domestic investment.It was not about “general equilibrium” or Pareto’s Law.

This makes “Petracrch’s”
analogy of the supposed behaviour of the “invisible hand” of the market with
the universal behaviour of “the laws of physics” highly suspect, especially the
analogy of decisions by the million, billions of “the molecules of a gas
distribute themselves so that there are very few particles with high energy or
with low energy, but with a great many at a point in between” analogous with the price
mechanisms in a market.Particles
on earth and elsewhere in the universe can be identified mathematically in the
sure knowledge that particles behave the same everywhere.

However,
self-interested individuals are not all identical at all, if at any, times.For a start, self-interested
individuals may, and often do, behave differently at different times and places.Their behaviour is not predictable
mathematically (despite years of teaching our students that they are
predictable).If they were it
would be a one-way bet for everybody who could write the maths, but nobody has
managed so far.

Self-interests can
be in conflict across a range of degrees and for economies, and self-interests are
and must be mediated by “persuasion” and by what Smith called the higgle,
haggle of bargaining (‘Wealth Of Nations’ and ‘Moral Sentiments’). Markets are
messy, always have been, always will be, and they are a vast improvement where
the operate than anything that preceded them in the history of the species.

There is no “hidden”
or “invisible hand” miraculousy working with deliberate intent in markets.Which is why Smith also pointed, on the
two (only) occasions where he used the “invisible hand” as a metaphor, that
individually motivated actions by individuals had "unintended
consequences”. And these “unintended consequences” are interesting to
economists and historians.They are
also of interest to theorists of evolution, which is blind, undirected, and
unpredictable.Much like atomic
particles, including isotopes, and sub-particles, unless you believe in a grand
designer intending the universe to be guided, though who or what designed the
grand designer?

2 Comments:

I think if an alien came from outer space and asked about our world and how it functions a good starting explanation would be Adam Smith's IH metaphor. That metaphor describes quite well how things fall into place.

But that metaphor is more than a metaphor. It is the real thing, describing a real activity that is going on around us. The invisible hand is like a magnet that brings scattered iron filings on a paper into order.

I don't think the article in The Statesman went far enough with the idea of thermodynamics and its link with the invisible hand. More should be said about thermodynamic's entropy effects on economics and how the abstraction of the invisible hand is the best way to combat it.

The invisible hand is first and foremost linked to the individual and about the individual pursuing self-interest. It is through individual pursuits that entropy is best combated, not through the collective, like we saw under communism, which allowed the economy to deteriorate and collapse. Ideas to combat entropy and its effects on economics come first from individuals who pursuit self-interests, not first from collectives that stifles individual interests.

" For best results, cultivate individuals, not groups." So to counter the negative effects of thermodynamics- economic entropy, cultivate individuals and their inner resources. The enigma of the invisible hand and the abstraction wrapped up in it plays well to that idea, which focuses on the individual. In progression, the group develops and balances itself on the pursuits of individuals.

For economic sustainability, which is the combating of entropy, cultivate the individual, not the group. In being cultivated the individual grows aware of the world and thus becomes enlightened and responsible. In this way the the individual is optimized and thus serve the whole of society better.